What does the resource-based model suggest a firm should do to earn above-average returns?

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Achieving competitiveness of a firm through the strategic modeling of above-average returns

Key Words: competitiveness, firm, strategic modeling, I/O model of above-average returns, resource-based model of above-average returns.

One of the urgent economic issues is achieving competitiveness of a firm.� Firms use the strategic management process to achieve strategic competitiveness and earn above-average returns. A firm achieves strategic competitiveness by developing and learning how to implement a value-creating strategy. Above-average returns (in excess of what investors expect to earn from other investments with similar levels of risk) are die foundation a firm needs to simultaneously satisfy all of its stakeholders.

The fundamental nature of competition is different in the current competitive landscape. As a result, those making strategic decisions must adopt a different mindset, one that allows them to learn how to compete in highly turbulent and chaotic environments that are producing disorder and a great deal of uncertainty. The globalization of industries and their markets and rapid and significant technological changes are the two primary factors contributing to the turbulence of the competitive landscape.

Firms use two major models to help them form their vision and mission and then choose one or more strategies to pursue strategic competitiveness and above-average returns.

The first model is called theI/O model of above-average returns. From the 1960s through the 1980s, the external environment was thought to be the primary determinant of strategies that firms selected to be successful. The I/O model of above-average returns explains the external environment�s dominant influence on a firm�s strategic actions. The model specifies that the industry or seg�ment of an industry in which a company chooses to compete has a stronger influ�ence on performance than do the choices managers make inside their organizations. The firm�s performance is believed to be determined primarily by a range of industry properties, including economies of scale, barriers to market en�try, diversification, product differentiation and the degree of concentration of firms in the industry [1].

Grounded in economics, the I/O model has four underlying assumptions. First, the external environment is assumed to impose pressures and constraints that deter�mine the strategies that would result in above-average returns. Second, most firms competing within an industry or within a segment of that industry are assumed to control similar strategically relevant resources and to pursue similar strategies in light of those resources. Third, resources used to implement strategies are assumed to be highly mobile across firms, so any resource differences that might develop be�tween firms will be short-lived. Fourth, organizational decision makers are assumed to be rational and committed to acting in the firm�s best interests, as shown by their profit-maximizing behaviors. The I/O model challenges firms to find the most attractive industry in which to compete and shape the structure of the industry to their advantage. Because most firms are assumed to have similar valuable resources that are mobile across companies, their performance generally can be increased only when they operate in the industry with the highest profit potential and learn how to use their resources to implement the strategy required by the industry�s structural characteristics.

Firms use an analytical tool called the five forces model of competition to help them find the industry that is the most attractive for them. The model encompasses several variables and tries to capture the complexity of competition. The five forces model suggests that an industry�s profitability (i.e., its rate of return on invested capital relative to its cost of capital! is a function of inter�actions among five forces: suppliers, buyers, competitive rivalry among firms cur�rently in the industry, product substitutes and potential entrants to the industry.

Firms use the five forces model to identify the attractiveness of an industry (as measured by its profitability potential) as well as the most advantageous position for the firm to take in that industry, given the industry�s structural characteristics.� Typically, the model suggests that firms can earn above-average returns by produc�ing either standardized goods or services at costs below those of competitors (a cost leadership strategy ) or by producing differentiated goods or services for which cus�tomers are willing to pay a price premium (a differentiation strategy) [2]. As an example, we can see that the Apple Company has used a clear differentiation strategy by creating computers and advancing new categories through design and hardware-software complemen�tarity, so that consumers see more value in Apple�s products and are willing to spend more. Some competing digital music players were cheaper, had more features and arguably better technical performance yet the perceived value of Apple�s suc�cessful products including the iPod, iPhone and the iPad exceeds that of other offerings.

The I/O model suggests that above-average returns are earned by firms able to effectively study the external environment as the foundation for identifying an attractive industry, or an attractive part of an industry in which to locate, and then by implementing the strategy that is appropriate in light of the characteristics of the chosen industry. Companies that develop or acquire the inter�nal skills needed to implement strategies required by the external environment are likely to succeed, while those that do not are likely to fail. Hence, this model sug�gests that returns are determined primarily by external characteristics rather than by the firm�s unique internal resources and capabilities.

Research findings support the I/O model, in that approximately 20% of a firm�s profitability is explained by the industry in which it chooses to compete. However, this research also shows that 36% of the variance in firm profit�ability is attributed to the firm�s characteristics and actions [3]. These findings sug�gest that the external environment and a firm�s resources, capabilities, core competencies and competitive advantages all influence the com�pany�s ability to achieve strategic competitiveness and earn above-average returns.

The I/O model considers a firm�s strategy to be a set of commitments and actions flowing from the characteristics of the industry in which the firm has decided to compete. The resource-based model, discussed next, takes a different view of the major influences on a firm�s choice of strategy.

The second model that we are going to take into consideration is the resource-based model of above-average returns. The resource-based model assumes that each organization is a collection of unique resources and capabilities. Theuniqueness of its resources and capabilities is the basis for a firm�s strategy and its ability to earn above-average returns.

Resources are inputs into a firm�s production process, such as capital equipment, the skills of individual employees, patents, finances and talented managers. In gen�eral, a firm�s resources are classified into three categories: physical, human and organizational capital. Resources are either tangible, or like knowledge, intangible in nature.

Individual resources alone may not yield a competitive advantage. �In fact, resources have a greater likelihood of being a source of competitive advantage when they are formed into a capability. A capability is the capacity for a set of resources to perform a task or an activity in an integrative manner. Capabilities evolve over time and must be managed dynamically in pursuit of above-average returns. Core competencies are resources and capabilities that serve as a source of competitive advantage for a firm over its rivals. Core competencies are often visible in the form of organizational functions [4].

According to the resource-based model, differences in performances across time occur primarily because of firms� unique resources and capabilities rather than because of the industry�s structural characteristics. This model also assumes that firms acquire different resources and develop unique capabilities based on how they com�bine and use the resources; that resources and certainly capabilities are not highly mobile across firms; and that the differences in resources and capabilities are the basis of competitive advantage. Through continued use, capabilities become stronger and more difficult for competitors to understand and imitate. As a source of competitive advantage, a capability �should be neither so simple that it is highly imitable, nor so complex that it defies internal steering and control� [5].

The resource-based model of above-average returns suggests that the strategy the firm chooses should allow it to use its competi�tive advantages in an attractive industry (the I/O model is used to identity an attrac�tive industry).

Not all of a firm�s resources and capabilities have the potential to be the founda�tion for a competitive advantage. This potential is realized when resources and ca�pabilities are valuable, rare, costly to imitate and nonsubstitutable. Resources are valuable when they allow a firm to take advantage of opportunities or neutralize threats in its external environment. They arerare when possessed by few, if any,current and potential competitors. Resources arecostly to imitate when other firms either cannot obtain them or are at a cost disadvantage in obtaining them com�pared with the firm that already possesses them. And they arenonsubstitutablewhen they have no structural equivalents. Many resources can either be imitated or substituted over time [6]. Therefore, it is difficult to achieve and sustain a competi�tive advantage based on resources alone. When these four criteria are met, how�ever, resources and capabilities become core competencies.

As noted previously, research shows that both the industry environment and a firm�s internal assets affect that firm�s performance over time. How a firm formu�lates and implements its strategy depends also on its founding condition as well as on strategic leadership. The founding conditions can imprint elements of the vision, mission and ethical standards of firms and this can have long term significance for a firm [7]. Consider how after more than one hundred years, the logo mark of General Electric (GE) is still reminiscent of the light bulb even though today GE stands for many other more profitable businesses. Founded by the inventor of the light bulb, it is still part of the company�s identity. Strategic leadership can change organizational identity. Nokia is a good example of a company that shifted from producing pulp, to manufacturing TVs, to designing mobile phones as lifestyle items and now smart phones. Thus, to form a vision and mission, and subsequently to select one or more strategies and to determine how to implement them, firms use both the I/O and the resource-based models. In fact, these models complement each other in that one (I/O) focuses outside the firm while the other (resource-based) focuses inside the firm.

To summarize, firms use two major models to help them form their vision and mission and then choose one or more strategies to pursue strategic competitiveness and above-average returns. The core assumption of the I/O model is that the firm�s external environment should have more influence on the choice of strate�gies than do the firm�s internal resources, capabilities and core competencies. Thus, the I/O model is used to understand the effects an industry�s characteristics can have on .a firm when deciding what strategy or strategies to use to compete against rivals. The logic supporting the I/O model suggests that above-average returns are earned when the firm locates an attractive industry or part of an in�dustry and successfully implements the strategy dictated by its characteristics. The core assumption of the resource-based model is that the firm�s unique resources, capabilities and core competencies should have more of an influence on selecting and using strategies than does the firm�s external envi�ronment. Above-average returns are earned when the firm uses its valuable, rare, costly-to-imitate, and nonsubstitutable resources and capabilities to compete against its rivals in one or more industries. Evidence indicates that both models yield insights that are linked to successfully selecting and using strategies. Thus, firms want to use their unique resources, capabilities and core competencies as the foundation for one or more strategies that will allow them to compete in industries they understand.

References:

1.        M. B. Lieberman and S. Asaba. Why do firms imitate each other? // Academy of Management Journal. - 2010. � No.31. � P. 366-385.

2.        M. E. Porter. Competitive Strategy. New York: Free Press, 1980. � 527 p.

3.        J. C. Short. D. J. Ketchen, Jr., T. B. Palmer and G. T. M. Hult. Firm, strategic group and industry influences on per�formance // Strategic Management Journal. � 2009. � No.28. � P. 147-167.

4.        A. M. McGahan. Competition, strategy and busi�ness performance // California Management Review. �- 2000. - �No.41(3). - P. 74-101.

5.        S. L. Newbert. Value, rareness, competitive advan�tage and performance: A conceptual-level empirical inves�tigation of the resource-based view of the firm // Strategic Management Journal. �� 2008. � No.29. � P. 745-768.

6.        C. Barroso and J. L. Galan. The resource-based theory: Dissemination and main trends // Strategic Man�agement Journal. � 2012. - No.27. � P. 621-636.

7.        E. Verwaal, H. Commandeur and W. Verbeke. Value creation and value claiming in strategic outsourcing decisions: A resource contingency perspective // Journal of Management. � 2010. � No.35. -� P. 420-444.

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